What Is Mortgage Amortization And How Is It Calculated?

When buying a home, your monthly mortgage payment can have a big impact on your plans. Mortgage amortization is the underlying math that determines what your payment is throughout the life of the loan and where those funds are going.

A clear understanding of mortgage amortization will help you outline how quickly you are building equity.

What Is Mortgage Amortization?

If you are considering homeownership, it’s important to understand the nuts and bolts of mortgage loans.

The two basics of any mortgage loan are the principal amount, which is the amount you borrow from the lender, and the interest payments. Mortgage amortization ties these two pieces of your home loan together.

Essentially, mortgage amortization is the loan’s schedule of repayment. It represents a balancing act between your interest payment and your principal payment. Each time you make a mortgage payment, the amount that goes toward your loan’s principal balance increases.

As you pay down the mortgage principal, you’ll build equity in the home. If you’re considering a mortgage refinance, the new loan will come with a new amortization schedule.

How Does Mortgage Amortization Work?

As a homeowner, you’ll pay a monthly mortgage payment that consists of principal, interest, taxes and insurance (PITI). If your tax obligations or insurance premiums change, that can cause your mortgage payment to fluctuate.

But if you have a fixed-rate mortgage, the underlying combination of principal and interest payment will remain the same. That means, you’ll always pay the same amount of principal and interest. Amortization maps out how much money goes towards the principal and how much goes to the interest each month.

At the beginning of your mortgage, a larger portion of your payment will go towards paying for the interest. With each payment, the amount sent towards interest will decrease. On the other side of the coin, the amount put towards your loan's principal will increase each month.

What Is A Mortgage Amortization Schedule?

An amortization schedule, or amortization table, gives you a breakdown of all your mortgage payments throughout the life of your loan.

Within the table, you’ll see your monthly payment divided into principal and interest portions. Additionally, you’ll see how much of your balance remains after that month’s payment.

Here’s an example of what an amortization schedule would look like. In this case, the homeowner has taken out a 30-year fixed rate loan with a 5% interest rate.

When you take out a mortgage, your lender will provide you with a copy of your amortization schedule.

How Is Mortgage Amortization Calculated?

Although you can easily calculate mortgage amortization with a ready-to-go calculator, understanding the underlying math is helpful. To get started, you’ll need to determine how much principal you owe, the months remaining on your loan term and the interest rate attached to the mortgage.

For example, let’s say you have a $250,000 30-year fixed-rate mortgage with an interest rate of 5%. Here’s how you’d calculate mortgage amortization.

We can plug the numbers into the amortization formula:

P x (r/n) x (1 + r/n) ^tXn / [(1 +r/n)^tXn -1]

First, calculate your monthly interest rate. In this case, we divide 0.05 by 12 to get a monthly interest rate of 0.0042. When you add 1, that becomes 1.0042.

Now, determine how many months are left on your mortgage. For this 30-year mortgage, we have 360 months left.

At this point, you can raise the monthly interest rate to the power of 360. You can use the (^) symbol on your calculator for this math. In this case, you’ll get 4.52, when rounded.

(0.0042 x 4.52) / (4.52 - 1) = 0.005393, when rounded

Finally, multiple this number by the principal portion of your mortgage:

0.005393 x $250,000 = $1,348.29

$1,348.29 is our estimated monthly payment. But with some rounding involved in our math, it might be a few dollars off. For the most accurate results, make sure to take advantage of a free, online mortgage calculator.

Calculating Mortgage Amortization With Extra Payments

Making extra payments will impact your mortgage amortization. If you want to save on interest payments, you can do a cash-in refinancing, mortgage recast or simply make extra payments towards the principal amount owed.

The amount you can save really adds up. For example, let’s say that you have $10,000 available to pay towards your principal balance of $250,000. With that lump sum payment, your mortgage is recast with a principal balance of $240,000 and the same 5% interest rate and loan term you had before.

Without any extra payments, you would’ve paid $233,139 in interest over the life of the loan. But if you pursue this recast two years into your term, you’ll only pay $204,970 in interest over the life of the loan. That’s a total interest savings of $28,169.

Although making extra payments isn’t always possible, it can lead to major interest savings.

Mortgage Amortization And Home Equity

Due to mortgage amortization, each payment you make puts a little bit more towards your principal balance. Over time, your mortgage payments will start making a bigger dent in your remaining balance.

As you pay down the balance, you’ll build home equity. But your home’s appreciation also plays a role in the amount of equity you own. Ultimately, the amount of equity you have in the home is equal to the home's current value minus the remaining principal balance on the loan.

With more equity, your loan-to-value ratio (LTV) increases. Depending on your situation, homeowners can decide to tap into that home equity through a cash-out refinance. You can pull out funds for any reason, such as tackling a renovation or paying off a big expense. But that withdrawal will impact your mortgage amortization and payments.

The Bottom Line: Every Monthly Mortgage Payment Brings You Closer to Owning Your Home Outright

As your mortgage amortizes, you’ll own more of your home with each payment because more money is going towards paying down the amount you owe. During the earliest years of repayment, the bulk of your mortgage payment goes towards paying interest debt. But at some point, the tables will turn and more of your payment will chip away at your loan balance.

Home equity is a powerful tool for your wallet. Sometimes, it makes sense to tap into your home equity through a cash-out refinance. Want to pursue this option? Apply online today.